BY ERIC I. STURDZA
The New Year marked a turn for the worst in risk aversion, concerns around the global economy and, most crucially, the ability of central banks and governments to prop up growth. Risk assets came down almost universally, along with further weakness in commodities, widening credit spreads, and the US 10y bond yield compressing back to 2%.
In the US, the forward-looking, discounting nature of markets was in clear display by pricing-in a scenario more akin to a mild recession than mere soft macro data. Retail sales were indeed weaker than already curbed expectations, and the industrial complex continued to suffer as the contractionary Empire Manufacturing and ISM Manufacturing indices showed. Fourth quarter GDP only grew by 0.7% quarter on quarter (annualized rate) in its first estimate, disappointingly low, further confirming the difficult environment created by the USD (for net exports), commodities (for Capex), and the absence of a hoped-for counterbalancing surge in personal consumption. In a continued display of strength however, the employment report surprised positively, and so did intermediate employment indicators such as jobless claims.
On the larger macroeconomic front, worries continue to center around the risk of a global recession and, most glaringly, how the world could combat it with the limited remaining central bank flexibility and the massive government debt loads restricting fiscal stimuli. Concerns over the Chinese economy and its ability to transition to a lower growth, consumption-led model are key, as the tail scenario of a hard landing would in all likelihood provoke significant currency devaluation, further commodity weakness and thus more deflationary forces worldwide.
Against this disappointing backdrop, the US equity market was also impacted by the launch of Q4 reporting. Generally, expectations had been taken down significantly in the past months, yet overall surprises remained muted. Revenue continued to be a more challenging bogey than earnings-per-share, and 2016 outlooks demonstrated executives’ caution towards global growth, including Europe, and expectations of further volatility across the board. Accordingly, corporate investment plans remain dominated by share repurchases and, according to JP Morgan’s earnings call, potential for further robust M&A. Foreign exchange continues to be an important headwind and source of uncertainty, and although not generalized, wage pressures in some sectors are showing signs of life, potentially benefiting consumption but concerning for margins. While top-lines remained below expectations, company executives did not seem to sense a negative inflection in the US consumer, and Visa, for example, while noting weakness in some part of the globe, encouragingly described US January business volumes as “strong”.
The Fund’s companies reported solid earnings so far, although with few rewards in the nervous stockmarket. Visa and MasterCard both published strong results in the face of volatile environment and currency pressures, with robust volumes and further signs of health in their underpinning theme, i.e. conversion from cash to plastic. MasterCard’s higher foreign currency exposure was the major culprit in the company’s muted 2016 outlook, but stability in operating metrics point to the networks’ strong positioning and secular nature of growth, the reason why the Fund retains its views on both companies. Signature Bank, one of the Fund’s few financial sector companies, reported earnings once again above expectations, with strong loan growth, credit quality and net interest margins. Its niche business model, focusing on their platform for bank teams servicing privately-owned businesses and their owners, continues to prosper, with efficiency ratios remaining best-in-class and further prospects for profitable organic growth. Apple also published earnings, this time slightly weak relative to expectations given lower momentum in iPhone sales and few other products to meaningfully contribute. Guidance for next quarter was the real focus of investors, given weakness implied by suppliers in prior weeks. While the number came in around most investors’ expectations, the tone of the call was more conservative than usual, noting the difficult economic environment in emerging markets and foreign currency challenges. While the company’s heart clearly beats to the iPhone cycle, currently in its down phase, the company’s current valuation implies a multi-year contraction of sales and margin erosion, comparable to secularly declining IT hardware companies. With impressive margin stability even in the most recent quarter, a new iPhone cycle expected in H2 2016, a sticky brand environment, a war chest of cash amounting to ca. 30% of market capitalization and innovative capabilities that should be ascribed some positive value, the Investment Adviser views this pessimism as overdone.
The current volatility in markets, the noticeable slump in global economic datapoints and the acerbic skepticism of global growth potential on the part of investors calls for a balanced approach: recognizing the importance of closely monitoring the fragile macroeconomic landscape for a negative inflection, while at the same time noting the increased risk premia now being offered in a market deprived of riskless propositions. The Fund retains 10-15% of cash exposure in this period of earnings publications in order to opportunistically add positions in companies with proven growth trajectories and attractive valuations.
The views and statements contained herein are those of Sturdza Private Banking Group in their capacity as Investment Advisers to the Fund as of 15/02/16 and are based on internal research and modelling.